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Key points of IFRS 10


Consolidated Financial
Statements in 40 questions and
answers

Key points of IFRS 10 Consolidated Financial Statements


in 40 questions and answers

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3

Key points of IFRS 10 Consolidated Financial Statements in 40 questions and answers

Summary

Introduction 6
1. When was IFRS 10 published and what is the mandatory effective date? 7
2. Does IFRS 10 replace other standards or interpretations? 7
3. What was the IASBs main objective? 8
4. Will IFRS 10 help to bring about convergence with US GAAP?  9
5. What is the new definition of control? 10
6. What new concepts are introduced in IFRS 10? 11
7. Must the purpose and design of the entity be taken into account, and if so,
how?  11
8. What are the definitions of substantive rights and protective rights?12
9. In practice, what elements should be considered when assessing whether or
not rights are substantive?13
10. In practice, what types of rights should be deemed protective rights?14
11. What is the difference between an agent and a principal (the concept of
delegated power)? 15
12. Are there any situations in which it is not necessary to take all these indicators
into account when assessing whether an investor is an agent or a principal? 17
13. How do you identify a de facto agent?18
14. How should franchises be dealt with?18
15. What are relevant activities? 19
16. How should an investor assess shared authority over relevant activities?20
17. What is the definition of a silo?20
18. What is the definition of power?21
19. What elements should be taken into consideration when assessing the level of
power over the entitys relevant activities? 22
20. What should an investor do in practice when voting rights are conclusive in
determining power? 22
21. What is the definition of de facto control? 23
22. How should an investor assess whether de facto control exists? 24
23. How should call options and other potential voting rights be taken into
account?25

Key points of IFRS 10 Consolidated Financial Statements


in 40 questions and answers

24. What elements should be taken into account when assessing power if voting
rights are not substantive?25
25. What are the main indicators for assessing the investors practical ability to
direct the entitys relevant activities? 26
26. If the above are not conclusive, what are the additional indicators? 26
27. What does IFRS 10 mean by special relationship? 27
28. In what situations should a large exposure to the variability of the entitys
returns be taken into account? 27
29. What is the definition of returns? 28
30. Is the concept of returns linked to a specific threshold?  29
31. But is there a de minimis threshold, below which the returns criterion would
probably not be met? 29
32. How should an investor assess whether it has the ability to use its power to
affect its rights/exposure to variable returns (i.e. whether there is a link between
power and returns)? 29
33. What are the steps to be followed when
applying IFRS 10? 30
34. Generally speaking, what elements should be examined in order to determine
whether the investor has the ability to direct the entitys relevant activities? 31
35. What are the rules on initial application of IFRS 10? 32
36. What are the requirements under IFRS 10 if there is no change in the level of
control? 34
37. What is the procedure for first-time consolidation linked to initial application of
IFRS 10? 34
38. What is the procedure when the group no longer controls an entity under IFRS
10? 35
39. Which sectors are likely to be the most affected?35
40. What are the key points to remember about IFRS 10? 36
Notes 38

Introduction

IFRS 10, which was published in May 2011, introduces a single definition of
control and replaces the portion of IAS 27 which related to consolidated financial
statements, as well as the SIC 12 interpretation on special purpose entities.
According to the IASBs schedule, the new standard is effective from 2013 for
entities with a reporting date at the end of the calendar year.
It may change the scope of consolidation (i.e. which entities should be
consolidated) but the consolidation techniques remain the same (i.e. how
to carry out consolidation).
In addition to the new definition of control, IFRS 10 includes clarifications on
various issues which were not previously addressed by the IFRS framework,
including:
the difference between protective rights and substantive rights;
de facto control;
the difference between an agent and a principal;
the concept of silos.
IFRS leaves a large amount open to professional judgement, particularly as
regards potential voting rights (e.g. call options).
Given the potential difficulties in applying this standard, it is essential that
all stakeholders familiarise themselves with it quickly particularly preparers
of financial statements, auditors and regulators.
To help with this, we have prepared the following series of 40 questions and
answers.

Key points of IFRS 10 Consolidated Financial Statements


in 40 questions and answers

1. WHEN WAS IFRS 10 PUBLISHED AND WHAT IS THE MANDATORY


EFFECTIVE DATE?
IFRS 10 Consolidated Financial Statements was published on 13 May 2011.
Application is mandatory for financial periods commencing on or after
1January2013 (for European entities, this is subject to adoption by the
European Union), and early application is permitted as long as the whole
consolidation package is applied simultaneously.
For a discussion on identifying the date of initial application for IFRS 10, cf.
question 35.
The other standards in the consolidation package, which were also published
on 13 May 2011, are as follows:
IFRS 11 Joint Arrangements;
IFRS 12 Disclosure of Interests in Other Entities;
IAS 27 Separate Financial Statements;
IAS 28 Investments in Associates and Joint Ventures.
However, if an entity voluntarily opts for early disclosure of some of the
information required under IFRS 12, it is not obliged to apply IFRS 12 in its
entirety, or the other standards relating to consolidation.
2. DOES IFRS 10 REPLACE OTHER STANDARDS OR
INTERPRETATIONS?
IFRS 10 introduces a single definition of control and replaces the portion
of IAS 27 which related to consolidated financial statements, as well as the
SIC12 interpretation on special purpose entities.
IAS 27 Separate Financial Statements now deals solely with recognition of
interests in subsidiaries, joint ventures and associates for entities preparing
separate financial statements under IFRS.
IFRS 10, which follows the ED10 exposure draft published in December2008,
changes the scope of consolidation (i.e. which entities should be consolidated)
but the consolidation techniques remain the same (i.e. how to carry out
consolidation).

Key points of IFRS 10 Consolidated Financial Statements in 40 questions and answers


8

The standard is quite short (the main body of the standard is only five pages
long, supplemented by a useful 38-page application guide) and leaves a large
amount open to professional judgement. As a result, there is likely to be plenty
of discussion between entities, their auditors and the regulators.
3. WHAT WAS THE IASBS MAIN OBJECTIVE?
By introducing a single definition of control, the IASB wanted to make it easier
to assess control without needing to know whether the entity fell within the
scope of SIC 12.
Readers will remember that the current definition of control under IAS 27
(the power to govern the financial and operating policies of an entity so as
to obtain benefits from its activities) primarily focuses on the ability to take
strategic decisions relating to the entitys operations or financing. In contrast,
SIC 12 is based upon an evaluation of risks and rewards
ED10 proposed a single definition of control but, as it attempted to bring
IAS27 and SIC 12 together into a single standard, it dealt with special purpose
entities (referred to as structured entities) separately. This was felt to be
inconsistent with the goal of introducing a single definition of control.
In response to the criticisms, the IASB has introduced a single definition
of control in IFRS 10 which is applicable in all cases, for both traditional
subsidiaries and special purpose entities, with no distinction between the
different types of entity.

Key points of IFRS 10 Consolidated Financial Statements


in 40 questions and answers

4. WILL IFRS 10 HELP TO BRING ABOUT CONVERGENCE WITH US


GAAP?
The project was begun in 2008 by the IASB and became a joint project in
October 2009.
However, in January 2011 the FASB decided not to develop a single consolidation
model which would apply to both voting interest entities and variable interest
entities (structured entities).
On withdrawing from the project, the FASB highlighted the following areas
where differences existed:
control in situations where the investor owns less than the majority
of the voting rights, and specifically the new guidance introduced by
IFRS 10 on the concept of de facto control;
the accounting treatment of potential voting rights, as the FASB did
not wish to take these into account when assessing control.
However, the IASB and FASB also have a joint project relating to investment
entities. The IASB published an exposure draft entitled Investment Entities
on 25 August 2011 and the comment period closed on 5 January 2012.
According to this project, entities which meet certain strict criteria must
measure their interests in subsidiaries, associates and joint ventures at fair
value through profit and loss.

Key points of IFRS 10 Consolidated Financial Statements in 40 questions and answers


10

5. WHAT IS THE NEW DEFINITION OF CONTROL?


Under IFRS 10, an investor controls an entity when it is exposed, or has rights,
to variable returns from its involvement with the entity, and has the ability to
affect those returns through its power over the entity. (IFRS 10.6)
An investor controls an investee when it is exposed, or has rights, to variable
returns from its involvement with the investee and has the ability to affect
those returns through its power over the investee.
In practice, an investor controls an entity if all the following conditions
are met:
the investor has power over the entity (cf. question 18);
the investor is exposed or has rights to variable returns from its
involvement with the entity (cf. question 29);
the investor has the ability to use its power over the entity to affect
the amount of these returns (i.e. there is a link between power and
variable returns, cf. question 32).
The standard also requires the investor to reassess its level of control over
an entity if facts or circumstances indicate that there may be changes to any
of the three conditions specified above.

Power

Returns

Link
between
power and
returns

Control must be
continuously
reassessed!

Control

Key points of IFRS 10 Consolidated Financial Statements


in 40 questions and answers

6. WHAT NEW CONCEPTS ARE INTRODUCED IN IFRS 10?


In addition to the new definition of control, and the changes to the scope of
consolidation, IFRS 10 includes additional clarifications on various specific
issues.
The new concepts introduced in IFRS 10 include:
substantive rights and protective rights (cf. question 8);
power exercised on behalf of a third party, which may distinguish
an agent from a principal (cf. question 11) or identify a de facto
agent (cf. question 13);
relevant activities (cf. question 15);
silos (cf. question 17);
returns (cf. question 29).
7. MUST THE PURPOSE AND DESIGN OF THE ENTITY BE TAKEN
INTO ACCOUNT, AND IF SO, HOW?
As a starting point, the standard recommends that preparers of financial
statements should consider the purpose and design of the entity in order to
assess how decisions relating to relevant activities are made, who currently
has the ability to direct these activities, and who has rights to returns from
these activities.
In a situation where voting rights (or similar rights) do not have a significant
effect on an entitys returns (as is generally the case for special purpose
entities, in the broad sense), it is all the more important to assess whether
the investor was involved when the entity was created.
If the investor was involved in creating the entity, this may indicate that the
investor had the opportunity to obtain sufficient rights to gain control of the
entity (even if this element is not sufficient in itself for the investor to be
deemed to have control of the entity).
The same applies in the case of instruments which include potential voting
rights, as taking these into consideration will help to shed light on the interests
and objectives of the various parties.

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Key points of IFRS 10 Consolidated Financial Statements in 40 questions and answers


12

8. WHAT ARE THE DEFINITIONS OF SUBSTANTIVE RIGHTS AND


PROTECTIVE RIGHTS?
IFRS 10 introduces the concept of substantive rights, which is to say rights
that are currently exercisable, and protective rights, which are solely designed
to protect the investor in specific situations.
The investor must assess both its own rights and those held by other parties.
SUBSTANTIVE

RIGHTS (CF. QUESTION 9)

To be considered substantive, rights must be exercisable when decisions on


relevant activities are made.
In practice, this generally means that the rights need to be currently exercisable
in order to be substantive (but there are exceptions to this).
Substantive rights which are not merely protective may also prevent the investor
from controlling the entity (e.g. if other parties have the right to approve or
block decisions relating to relevant activities).
PROTECTIVE

RIGHTS (CF. QUESTION 10)

Rights are considered to be protective if they relate to fundamental changes


in the entitys activities or only apply in exceptional circumstances.
The purpose of protective rights is solely to protect the interests of their
holder, rather than to transfer power to that party.

Key points of IFRS 10 Consolidated Financial Statements


in 40 questions and answers

9. IN PRACTICE, WHAT ELEMENTS SHOULD BE CONSIDERED WHEN


ASSESSING WHETHER OR NOT RIGHTS ARE SUBSTANTIVE?
Professional judgement is required in order to determine whether or not
rights are substantive. Various factors should be considered, including the
three points below.
1. The existence of barriers (economic, legal, etc.) which would prevent
the holder(s) from exercising the rights, such as:
financial penalties and incentives for exercising or not exercising
rights;
an exercise price that would create a financial barrier to exercising
rights;
a very short exercise period for the rights;
the inability of the rights holder to obtain the information necessary
to exercise the rights;
operational barriers (such as the lack of another manager willing
or able to provide the same services as the current manager);
legal or regulatory constraints (e.g. in the case of a foreign investor).
2. Whether or not the exercise of the rights in question requires
agreements from other parties (and if so, whether there is a
mechanism in place to allow these parties to exercise their rights).
In practice, the likelihood that the rights are substantive is inversely
proportional to the number of parties involved (i.e. the more parties
involved, the more difficult it will be to obtain agreement from all
the various parties).
3. Whether or not the rights holder would benefit from exercising the
rights.
For example, in the case of potential voting rights, the exercise
price (or conversion price) of the instrument should be taken into
consideration.

13

To be considered substantive,
rights must be exercisable when decisions
on relevant activities are made.

Substantive rights

Key points of IFRS 10 Consolidated Financial Statements in 40 questions and answers


14

Whether or not the rights holder would benefit may also depend on
whether significant synergies would be possible (if the rights were
exercised), as the concept of returns is broader than the concept
of benefits as in IAS 27 (cf. question 29).

Are there barriers


(economic, legal, etc.)?
Must agreement be obtained
from other parties?
Would the rights holder benefit
from exercising the rights?

10. IN PRACTICE, WHAT TYPES OF RIGHTS SHOULD BE DEEMED


PROTECTIVE RIGHTS?
Examples of protective rights include:
a lenders right to restrict a borrowers activities (that is, activities
which could result in a significant deterioration of the borrowers
credit risk);
a right of veto held by a minority shareholder over significant capital
expenditure (greater than that required in the normal course of
business) or over the issue of equity or debt instruments;
a lenders right to seize a borrowers assets in the case of default on
a loan.

Key points of IFRS 10 Consolidated Financial Statements


in 40 questions and answers

11. WHAT IS THE DIFFERENCE BETWEEN AN AGENT AND A


PRINCIPAL (THE CONCEPT OF DELEGATED POWER)?
IFRS 10 makes explicit the concept of the agent and the principal, where the
power over an entity is delegated.
Thus, in practice, when a party has the ability to direct the relevant activities
of the entity (i.e. the power criterion is met), the following four indicators
should be considered in order to assess whether the decision-maker is acting
as the principal (i.e. on its own account and in its own interests) or as an
agent (i.e. for a third party).
1. The scope of the decision-makers authority
The scope of its decision-making authority depends on both the activities
that are permitted under the decision-making agreement, and the
discretion that the decision-maker has over those activities.
2. Rights held by other parties
In a situation where the decision-maker may be removed without cause
by a single other party, the decision-maker is considered to be an agent.
If the removal right must be exercised jointly by several other parties,
it is necessary to assess whether or not the right is substantive.
If there are only a small number of other parties involved, the decisionmaker is generally considered to be an agent (if the removal right is
substantive).
Liquidation rights may also deprive the decision-maker of its decisionmaking power, and thus potentially have the same implications as
removal rights.
3. The type of remuneration
The greater the magnitude and variability of the remuneration, the more
likely the decision-maker is acting on its own account (as the decisionmaker is then assumed to have acted in its own best interests).
In order for the decision-maker to be considered an agent, the following
two conditions must be met:
the remuneration must be commensurate with the services provided
(i.e. market conditions);

15

Key points of IFRS 10 Consolidated Financial Statements in 40 questions and answers

the terms of the agreement must be in line with those usually


stipulated in agreements for provision of this type of service.
However, receiving normal remuneration is not sufficient in itself for
a decision-maker to be considered an agent.
4. Exposure to variability of returns (from the decision-makers interests
in the entity, other than those directly relating to its remuneration for
services)
When a party with decision-making power has an interest in an entity
(e.g. an investment in the entity, provision of guarantees, etc.), it is
necessary to consider whether it is an agent or a principal.
It is particularly important to consider the following elements:
the relative magnitude and variability of the interest;
the decision-makers exposure to variability of returns, compared
with that of other investors (i.e. if the decision-makers interests
differ from those of other investors, this could influence its
behaviour).
As well as introducing the concept of the agent-principal relationship,
IFRS 10 also makes reference to the concept of the de facto agent
(cf. question 13).
Distinguishing between an agent and a principal

Over what activities?


How much discretion?

al
f remov
Right o use by a
ca
without
ent
rty ag
a
p
le
sing

Scope of
authority

Exposure to
variability of
Relative magnitude?
returns
Variability?
Are interests in line with those
of other investors?

16

Other
parties
rights

Removal
rights?
Liquidation rights?

Type of
remuneration

arket
Non m
ration
e
n
u
rem
ipal
c
n
pri

Market rate remuneration?


Market conditions?

Key points of IFRS 10 Consolidated Financial Statements


in 40 questions and answers

12. ARE THERE ANY SITUATIONS IN WHICH IT IS NOT NECESSARY


TO TAKE ALL THESE INDICATORS INTO ACCOUNT WHEN
ASSESSING WHETHER AN INVESTOR IS AN AGENT OR A
PRINCIPAL?
Generally speaking, all the indicators listed in question 11 must be taken into
consideration when assessing whether an entity is an agent or a principal.
However, if the decision-maker can be removed without cause by a single
other party, it is not necessary to continue with the analysis: this in itself is
sufficient to determine that the decision-maker is an agent.
Similarly, if the decision-makers remuneration is not market-based, the
decision-maker is deemed to be acting on its own account (i.e. it is the
principal, except in the unlikely event that it can be removed without cause
by a single other party).
IFRS 10 includes several examples pertaining to a fund manager, which are
intended to aid understanding of the principles set out in the standard in a
particular practical situation.
Notwithstanding the fact that each situation must be examined with regard
to its specific facts and circumstances, the fact that the fund manager owns
around 20% of the shares in the fund in question means that consolidation
is likely to be required (unless the other investors hold substantive removal
rights).
Thus, while these examples are for illustrative purposes only, the example threshold of
around 20% is significantly lower than that generally used previously (i.e. the majority
of risks and rewards under SIC 12).

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Key points of IFRS 10 Consolidated Financial Statements in 40 questions and answers


18

13. HOW DO YOU IDENTIFY A DE FACTO AGENT?


IFRS 10 also introduces the concept of the de facto agent, i.e. a party acting
on the investors behalf.
For example, the parties described below could be considered to be de facto
agents for the investor, due to the nature of their relationship with said investor:
the investors related parties;
a party that received its interest in the entity as a contribution (or
as a loan) from the investor;
a party that has agreed not to sell its interest in the entity without
the investors prior agreement;
a party that cannot finance its operations without subordinated
financial support from the investor;
an entity for which more than half the members of its governing
body (or its key management personnel) are the same as those of
the investor;
a party that has a close business relationship with the investor (e.g.
a service provider and one of its major clients).
Given the highly subjective nature of the concept of the de facto agent, it is
currently difficult to say what impact this new guidance will have in practice
in the future.
14. HOW SHOULD FRANCHISES BE DEALT WITH?
IFRS 10 also discusses franchises, stipulating that the existence of a franchise
agreement does not usually give the franchisor power over the franchisee.
This is because franchisors rights normally exist in order to protect the brand
and the franchisee directs its activities in its own interests, even though this
must be done in accordance with the terms of the franchise agreement.

Key points of IFRS 10 Consolidated Financial Statements


in 40 questions and answers

15. WHAT ARE RELEVANT ACTIVITIES?


The definition on power also makes reference to the concept of relevant
activities, i.e. the activities that significantly affect the entitys returns.
(IFRS10 Appendix A)
Relevant activities (...) activities of the investee that significantly affect the
investees returns.
Many entities will have various activities which significantly affect their
returns, such as:
the sale and purchase of goods and services;
selecting, purchasing and disposing of assets;
obtaining funding (and determining a funding structure);
researching and developing new products;
managing financial assets throughout their lifetime (including upon
default);

Examples of decisions relating to relevant activities include preparing budgets, or
appointing and devising a remuneration policy for key management personnel.
Thus, for many entities, relevant activities correspond to the operating and
financial activities used for assessing control under IAS 27 (cf. question 3).
In some cases, relevant activities are directly linked to the occurrence of a
specific event (for example, the ability to manage the entitys assets upon
default).

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Key points of IFRS 10 Consolidated Financial Statements in 40 questions and answers


20

16. HOW SHOULD AN INVESTOR ASSESS SHARED AUTHORITY OVER


RELEVANT ACTIVITIES?
The authority to direct relevant activities may be shared, either because the
entity has various relevant activities, or because the direction of relevant
activities changes over time.
When the power is shared by several entities (i.e. several investors have the
ability to direct different relevant activities), the investor with the greatest
ability to affect the entitys returns is deemed to have control (assuming that
these activities have a significant impact on the entitys results).
If several investors have the ability to direct relevant activities at different
times, it is necessary to assess which investor has the greatest impact on
the entitys returns.
Example:
Investor A is in charge of developing a medical product (and obtaining the necessary
regulatory approval), while investor B is responsible for producing and marketing the
product (after the development stage).
In order to determine which of A or B has the greatest impact on the entitys returns,
all the facts and circumstances must be taken into account, particularly the uncertainty
involved in obtaining regulatory approval.
This example, which is taken from the application guidance for IFRS 10, lists the elements
to be taken into consideration but does not provide an answer.

17. WHAT IS THE DEFINITION OF A SILO?


In practice, when a structure can be divided into different portions (e.g. in the
case of portfolios of receivables sold to an entity), it can sometimes be difficult
to identify the entity to be consolidated (if consolidation is indeed required).
IFRS 10 clarifies the concept of a separate entity within a larger structure
(sometimes called a silo) and stipulates that only the silo controlled by
the investor should be consolidated (i.e. not the larger structure).
In the event that all the assets, liabilities and equity of the silo are totally
separate from the larger structure (i.e. the investee), the silo is deemed to be
ring-fenced and control needs to be assessed at the level of the separate entity.

Key points of IFRS 10 Consolidated Financial Statements


in 40 questions and answers

18. WHAT IS THE DEFINITION OF POWER?


Under IFRS 10, power is defined as the current ability to direct the activities
that significantly affect the investees returns. (IFRS 10.10)
An investor has power over an investee when the investor has existing rights
that give it the current ability to direct the relevant activities, i.e. the activities
that significantly affect the investees returns.
Readers will remember that IAS 27 defines control as the power to govern
the financial and operating policies of an entity so as to obtain benefits from
its activities.
Although directing an entitys financial and operating policies often equates to having
control, the Board justified its decision to change the definition by pointing out that
power can also be obtained in other ways.

Thus, according to the definition of control given in IFRS 10, power arises
from rights and it is not necessary to have actually directed activities in order
to have control (the ability to direct activities is sufficient).
The exercise of power thus involves identifying relevant activities (cf. question15),
how decisions are made about these relevant activities, and what are the rights
over the entity held by the investor and by other parties.
However, only substantive rights (cf. question 9) are taken into account in the analysis,
not protective rights (cf. question 10).

19. WHAT ELEMENTS SHOULD BE TAKEN INTO CONSIDERATION


WHEN ASSESSING THE LEVEL OF POWER OVER THE ENTITYS
RELEVANT ACTIVITIES?
Key rights to be taken into consideration include:
voting rights (current and potential);
contractual arrangements with other investors (especially those
relating to the obtaining of proxies from other holders of voting
rights);
the right to appoint or remove an entitys key management personnel
(i.e. the individuals with the ability to direct the relevant activities);
the right to appoint or remove another entity that directs the relevant
activities;
the contractual right to direct the relevant activities (e.g. as specified
in a management contract).

21

Key points of IFRS 10 Consolidated Financial Statements in 40 questions and answers


22

The standard also addresses situations where the entitys relevant activities
are actually directed by the government, a court, a regulator or a liquidator,
in which case the investor which holds the majority of the voting rights does
not have power over the entity.
In some sectors, such as defense, a foreign majority shareholder may be required to
transfer its voting rights to independent citizens of the country in which the entity is
based. These citizens must exercise their rights in order to protect the entity from any
external influence.

In practice, it will usually be a question of assessing whether voting rights are


conclusive (cf. question 20), or not (cf. question 24), in determining power
over the entity.
20. WHAT SHOULD AN INVESTOR DO IN PRACTICE WHEN VOTING
RIGHTS ARE CONCLUSIVE IN DETERMINING POWER?
The process of assessing rights may be quite simple when power results
from the exercise of voting rights (and when there are no other elements
to complicate the situation, such as additional contracts or potential voting
rights). However, in more complex situations it may be necessary to examine
all the facts and circumstances before drawing conclusions.
Generally speaking, when an entity has various activities that affect returns,
and substantive decision-making is required continuously, power is determined
by voting rights and other similar rights, either in isolation or together with
other contractual arrangements.
When voting rights do not have a significant effect on the entitys returns (as
when voting rights relate to administrative decisions only), the investor must
assess all the contractual arrangements.
Going beyond the most simple cases (where holding the majority of the voting
rights determines control), IFRS 10 makes the following additional provisions:
it clarifies the fact that de facto control exists under IFRS (cf.
question 21);
it changes the way in which potential voting rights should be taken
into consideration when assessing control (cf. question 23).

Key points of IFRS 10 Consolidated Financial Statements


in 40 questions and answers

Assessing power in traditional entities


Majority of voting rights held
- Assess potential voting rights
- What rights are held by third parties?

Majority of voting rights not held


- Are there arrangements with other
shareholders?
- Assess potential voting rights
- Contractual rights (to appoint or remove
key management personnel, etc.)?
- De facto control (based on the
percentage of voting rights held, the
dispersal of voting rights among other
shareholders, other shareholders voting
patterns at general meetings, etc.)

21. WHAT IS THE DEFINITION OF DE FACTO CONTROL?


De facto control, i.e. when an investor has power even without holding the
majority of the voting rights, is now explicitly recognised under IFRS.
Readers may remember that the IASB made a statement on this subject in
the October 2005 IASB Update, explaining that de facto control was included
under IAS 27, but acknowledging that the lack of guidance in the standard
could result in inconsistent application.
IFRS 10 now clarifies that the power criterion may be met if the investor has
the practical ability to direct the relevant activities unilaterally, even if it does
not hold the majority of the voting rights.

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Key points of IFRS 10 Consolidated Financial Statements in 40 questions and answers


24

22. HOW SHOULD AN INVESTOR ASSESS WHETHER DE FACTO


CONTROL EXISTS?
In order to assess whether it has the practical ability to direct the entitys
activities, an investor should consider the following:
the relative size of its holding, taking into account the dispersal of
holdings owned by other investors. The larger the investors holding,
and the greater the number of other shareholders that would be
needed to outvote the investor, the more likely it is that the investor
has the ability to direct the entitys activities;
the potential voting rights held by the investor (and by other parties);
rights resulting from other contractual arrangements;
all the facts and circumstances which indicate that the investor has,
or does not have, the current ability to direct the entitys activities
at the time when decisions are made (including voting patterns at
previous shareholders meetings).
Example:
If the percentage of voting rights exercised at previous shareholders meetings was
between 70% and 75%, the shareholders have not arranged to make collective decisions,
and no other shareholder owns more than 5% of the voting rights, then a 40% holding
of voting rights may be sufficient to give the investor control of the entity.

If an assessment of the first three indicators is not conclusive, then all the
facts and circumstances must be taken into consideration.
In this case, the investor must assess (a) the indicators which shed light
on the investors practical ability to direct the entitys relevant activities (cf.
question25) and, if necessary, (b) additional indicators (cf. question 26).
Although these various indicators are more generally used in the case of structured
entities, it may sometimes be necessary to use them in the case of traditional entities.

Key points of IFRS 10 Consolidated Financial Statements


in 40 questions and answers

23. HOW SHOULD CALL OPTIONS AND OTHER POTENTIAL VOTING


RIGHTS BE TAKEN INTO ACCOUNT?
Readers will remember that the current IAS 27 requires potential voting rights
to be taken into account (i.e. call options and other currently exercisable
instruments) when assessing the percentage of control (this is a standardised
calculation, and the groups intentions and financial capacity are not taken
into account).
Under IFRS 10, only substantive potential voting rights are taken into account.
When assessing control, an entity shall consider whether the ability to obtain
voting rights arising from options (and other convertible instruments) gives
it the ability to direct the activities of another entity when coupled with other
relevant facts and circumstances.
The following shall be taken into consideration in this assessment:
the purpose and design of these instruments (and especially the
investors original motives) (cf. question 7);
the terms and conditions of the instruments (exercise price, exercise
periods, etc.);
the benefits which the investor could derive from exercising these
instruments (economies of scale, synergies, etc.).
The Board states that, given that a range of elements must be taken into
consideration, changes in market conditions (such as changes in the market
value of the securities) should not normally change the conclusions reached
on whether or not the investor has control over the entity.
The practical application of this complex issue is likely to result in a great
deal of discussion, given the large part played by professional judgement in
reaching a decision.
24. WHAT ELEMENTS SHOULD BE TAKEN INTO ACCOUNT WHEN
ASSESSING POWER IF VOTING RIGHTS ARE NOT SUBSTANTIVE?
IFRS 12 uses the term structured entity to refer to entities in which voting
rights (or similar rights) are not the dominant factor in determining who controls
the entity in question (for example, when voting rights relate to administrative
tasks and activities are directed through contractual arrangements).
Readers will remember that the concept of a structured entity was introduced in the
exposure draft (ED10) published in December 2008.

25

Key points of IFRS 10 Consolidated Financial Statements in 40 questions and answers

Many commentators criticised the fact that ED10 proposed a differentiated approach to
control, noting that this was not consistent with the Boards objective of introducing a single
definition of control which would apply to both traditional and special purpose entities.

The elements to be taken into consideration comprise a series of indicators


for assessing the investors practical ability to direct the entitys relevant
activities (cf. question 25) plus two additional indicators of lesser importance
(cf. question 26).
25. WHAT ARE THE MAIN INDICATORS FOR ASSESSING THE
INVESTORS PRACTICAL ABILITY TO DIRECT THE ENTITYS
RELEVANT ACTIVITIES?
In order to determine whether the investor has the practical ability to direct
the entitys relevant activities unilaterally, the following indicators should be
assessed initially:
the investor can (without having the contractual right to do so)
appoint the key management personnel who have the ability to direct
activities;
the investor can (without having the contractual right to do so) direct
the entity to carry out significant transactions for the benefit of the
investor;
the investor can dominate the process for nominating members
of the entitys governing body (or can obtain proxies from other
shareholders);
the entitys key management personnel are related parties of the
investor;
more than half of the members of the entitys governing body are
related parties of the investor.
26. IF THE ABOVE ARE NOT CONCLUSIVE, WHAT ARE THE
ADDITIONAL INDICATORS?
If the assessment of the first series of indicators is inconclusive, additional
indicators must be taken into consideration.
The additional indicators, which are considered less important, include the
existence of a special relationship (cf. question 27) and a large exposure to
the variability of the entitys returns (cf. question 28).

26

Key points of IFRS 10 Consolidated Financial Statements


in 40 questions and answers

27. WHAT DOES IFRS 10 MEAN BY SPECIAL RELATIONSHIP?


If the investor has a special relationship with the entity, suggesting that the
investor has more than a passive interest in the entity, other indicators must
be examined (although they are deemed to be less important than the first
series of indicators):
the entitys key management personnel (who have the ability to direct
activities) are current or former employees of the investor;
the entitys operations are dependent on the investor:
because the entity depends on the investor for a significant portion
of its funding, technology, raw materials, etc.;
because the investor guarantees a significant portion of the entitys
obligations;
because the investor controls assets (such as licences or trademarks)
that are critical to the entitys activities;
because the entity depends on the investor for its key management
personnel;
a significant portion of the entitys activities involve or are conducted
on behalf of the investor;
the investors exposure, related to its involvement with the entity, is
disproportionately greater than its voting rights (or other rights).
The use of this second series of indicators to assess control is likely to prove
particularly complex in practice, given that the standard states that the existence
of a special relationship does not necessarily indicate control over the entity.
28. IN WHAT SITUATIONS SHOULD A LARGE EXPOSURE TO THE
VARIABILITY OF THE ENTITYS RETURNS BE TAKEN INTO
ACCOUNT?
IFRS 10 states that power and exposure to returns are usually closely linked.
As a result, if the investor has a large exposure to the variability of the entitys
returns, this is likely to indicate that the investor has power (although this
indicator is less important than the first series of indicators).
However, consolidation must nonetheless be based on control (even in the
event that the parent company does not have the majority of the risks and
rewards from the entity in question).

27

Key points of IFRS 10 Consolidated Financial Statements in 40 questions and answers


28

Structured entities will be particularly challenged by the requirement to


regularly reassess the level of control, given the greater reliance on individual
judgement (in comparison with traditional entities) and the difficulty of
carrying out the analysis.
29. WHAT IS THE DEFINITION OF RETURNS?
Returns vary in line with the entitys activities and may be positive or negative
(or both positive and negative). The legal form of the returns is not significant.
IFRS 10 uses a very broad definition of returns, including but not limited to:
dividends (and other economic distributions from a subsidiary) and
changes in the value of the subsidiary;
remuneration for services provided, access to liquidity, tax benefits,
etc.;
returns that are not available to other shareholders (economies of
scale, synergies, access to scarce products, etc.).
Thus, in practice, a bond with fixed interest payments is deemed to give the
investor rights/exposure to variable returns as the interest payments expose
the investor to the entitys credit risk.
Similarly, fixed performance fees for managing an asset are also deemed to
be variable returns.
The concept of benefits used in IAS 27 was not specifically defined, but
was generally interpreted narrowly and limited to benefits directly linked to
the ownership of securities.

Key points of IFRS 10 Consolidated Financial Statements


in 40 questions and answers

30. IS THE CONCEPT OF RETURNS LINKED TO A SPECIFIC


THRESHOLD?
The concept of exposure to variable returns is not dependent on crossing a
specific threshold.
In contrast to interpretation SIC 12, which referred to the majority of risks and
rewards, IFRS 10 does not stipulate a threshold above which consolidation
is necessary.
As stated above, control generally implies exposure (whether positive or
negative) to variable returns, but the Board did not wish to introduce a specific
threshold (no bright line).
31. BUT IS THERE A DE MINIMIS THRESHOLD, BELOW WHICH THE
RETURNS CRITERION WOULD PROBABLY NOT BE MET?
Although there is no official threshold, the examples provided in the standard
do nonetheless give some indication of the level above which the issue needs
to be seriously considered.
In practice, in the examples provided for fund managers (cf. question 12 on
delegated power), the IASB seems to implicitly suggest that 20% ownership of
an entity is sufficient for the exposure to variable returns condition to be met.
32. HOW SHOULD AN INVESTOR ASSESS WHETHER IT HAS THE
ABILITY TO USE ITS POWER TO AFFECT ITS RIGHTS/EXPOSURE
TO VARIABLE RETURNS (I.E. WHETHER THERE IS A LINK
BETWEEN POWER AND RETURNS)?
In practice, an investor with power over an entity must determine whether it
is acting as an agent (i.e. on behalf of another organisation) or as a principal
(i.e. on its own account) (cf. question 11).
The link between power and returns does not mean that the proportion of the
entitys returns due to the investor must be perfectly in line with the amount
of power it holds; it simply means that the parent company must have the
ability to influence the entitys returns on its own behalf.

29

Key points of IFRS 10 Consolidated Financial Statements in 40 questions and answers

33. WHAT ARE THE STEPS TO BE FOLLOWED WHEN


APPLYING IFRS 10?
The first thing to note is that the standard does not incorporate a decision
tree or propose a structured analysis approach.
As there is a single definition of control for both traditional and structured
entities, this means that some of the provisions are more or less applicable
depending on the type of entity.
Given the lack of a decision tree, we suggest that in the majority of cases
encountered in practice, preparers of financial statements should consider
the questions below in order to reach a conclusion on the level of control
over an entity.
The following questions should be considered:
1. At what level should the analysis of control be carried out?
Cf. question 17 the silo concept.
2. What are the activities that significantly affect the entitys returns (i.e.
the relevant activities)?
Cf. question 15 the concept of relevant activities.
3. How are decisions made about the entitys relevant activities?
4. Does the investor have the ability to direct the entitys relevant
activities?
At this stage, in practice, it will usually be useful to identify whether
or not voting rights are a significant factor in determining control,
and to select an approach accordingly (cf. question 34 for a practical
approach which differentiates between traditional and structured
entities).
5. Does the investor have rights/exposure to variable returns?
Cf. question 29 the concept of (positive or negative) exposure to
variable returns.
6. Does the investor have the ability to use its power over the entity to
affect the amount of these returns, in its own interest?
Cf. question 11 the distinction between an agent and a principal.

30

Key points of IFRS 10 Consolidated Financial Statements


in 40 questions and answers

34. GENERALLY SPEAKING, WHAT ELEMENTS SHOULD BE EXAMINED


IN ORDER TO DETERMINE WHETHER THE INVESTOR HAS THE
ABILITY TO DIRECT THE ENTITYS RELEVANT ACTIVITIES?
There are many elements which may need to be considered, depending on
the situation. The table below is intended only to show the most common
scenarios in a simplified form (with reference to the relevant sections).
Traditional entities

Structured entities

Voting rights are important for


determining control

Voting rights are less important


for determining control,
in contrast to contractual
arrangements

Voting rights held


Substantive
rights only
Q.9

The concept of power


and the rights held by the
entity (and by third
parties) Q.20
Potential voting rights

Q.23

De facto control

Q.22

Purpose and design


of the entity

Q.7

Practical ability
to exercise power

Q.25

Special relationship

Q.27

Level of exposure
to variability of returns

Q.28

31

Key points of IFRS 10 Consolidated Financial Statements in 40 questions and answers


32

Assessing power in the case of structured entities (a visual summary)


Practical ability to exercise power

Special relationship

- Can appoint key management personnel


(who have the ability to direct activities)

- The entitys key management personnel


are current or former employees of the
investor

- Can direct the entity to carry out


significant transactions for the benefit of
the investor
- Can dominate the process for
nominating members of the governing
body
- The entitys key management personnel
are related parties of the investor
- The majority of the members of the
entitys governing body are related
parties of the investor
Do not forget (a) the purpose and design
of the entity and (b) the exposure to
variability of returns

- The entitys operations are dependent


on the investor
for funding, technology, raw materials,
etc.;
- because the investor controls assets
that are critical to the entitys activities
(licences, trademarks, etc.);
- because the investor acts as a
guarantor for the entity;
- for its key management personnel.
- A significant portion of the entitys
activities involve or are conducted on
behalf of the investor
- The investors exposure, related to
its involvement with the entity, is
disproportionately greater than its
voting rights (or other rights)

35. WHAT ARE THE RULES ON INITIAL APPLICATION OF IFRS 10?


As stated above (cf. question 1), application of the standard is mandatory for
financial periods commencing on or after 1 January 2013 (for European entities,
this is subject to adoption by the European Union), and early application is
permitted as long as the whole consolidation package is applied simultaneously.
The accounting treatment stipulated by IFRS 10 is retrospective, in principle.
The following three situations are possible:
no change in the level of control (cf. question 36);
consolidation required for the first time (cf. question 37);
deconsolidation required (cf. question 38).

Key points of IFRS 10 Consolidated Financial Statements


in 40 questions and answers

Has the level of control changed?


Yes
First time consolidation

Do nothing
No

Deconsolidation

But retrospective adjustment is


permitted

Principle: Retrospective adjustment


Exceptions permitted if impracticable (as defined in IAS 8)
Deemed acquisition date =
Beginning of earliest period for
which application of IFRS 3 is
practicable

Deemed date of loss of control


= Beginning of earliest period
for which application of IFRS 10
is practicable

Mandatory for
financial periods
commencing on or after
1 January 2013

Is a business
(as defined in IFRS 3)
IFRS 3

Early application permitted (if


IFRS 10, 11, 12 and IAS 27 & 28
are applied simultaneously)

Is not a business
IFRS 3 (but no goodwill)

Subject to adoption
by the EU!

The IASB published an amendment to IFRS 10 on 28 June 2012, which aimed


to clarify the Boards original intentions regarding the date of initial application.
Remember that the date of initial application is the date on which the investor should
determine whether it controls the entity on the basis of the requirements of IFRS 10.

According to this document, the date of initial application should be understood


as the start of the period in which IFRS 10 is applied for the first time (i.e.
1January 2013 in the example above).

33

Key points of IFRS 10 Consolidated Financial Statements in 40 questions and answers


34

36. WHAT ARE THE REQUIREMENTS UNDER IFRS 10 IF THERE IS NO


CHANGE IN THE LEVEL OF CONTROL?
If the level of control is deemed to be unchanged when it is assessed at the
date of initial application, there is no need to adjust the accounts.
However, the wording used in IFRS 10 seems to permit the option of genuinely
retrospective application.
Thus, for example, the date on which the investor obtained control may differ depending
on whether the analysis was based on IAS 27 / SIC 12 or on IFRS 10 (e.g. due to the
differing treatment of potential voting rights).
The amendment published in June 2012 clarifies that it is not necessary to restate
retrospectively the comparative periods presented if an entity which was unconsolidated
under IAS 27 / SIC 12 but which would have been consolidated under IFRS 10 (or vice
versa) has been disposed of before 1 January 2013.

37. WHAT IS THE PROCEDURE FOR FIRST-TIME CONSOLIDATION


LINKED TO INITIAL APPLICATION OF IFRS 10?
When retrospective application is impracticable (as defined in IAS 8, that is:
when the entity cannot apply it after making every reasonable effort to do so),
the following specific rules apply.
Where an investor is consolidating an entity for the first time, IFRS 10 permits
the use of a deemed acquisition date, which is the beginning of the earliest
period for which application of IFRS 3 is practicable (which may be the period
of initial application of the revised standard).
In practice, application of IFRS 3 could take place on 1 January 2013 for an entity which
has a reporting date at the end of the calendar year and which has not opted for early
application.

IFRS 3 shall therefore be applied at the deemed acquisition date. However, if the
entity is not a business (as defined in IFRS 3), no goodwill can be recognised.
As the standard is generally to be applied retrospectively, this raises questions over
which version of IFRS 3 should be used. This is a significant issue, due to changes in
the definition of a business.

Key points of IFRS 10 Consolidated Financial Statements


in 40 questions and answers

Readers will remember that the revised IFRS 3 (published in 2008) was prospectively
applicable (i.e. for business combinations taking place in financial periods starting on
or after 1 July 2009).
The amendment published on 28 June 2012 clarifies that IFRS 3 (2008) must be used if
control was obtained later than the effective date of IFRS 3 (2008). If control was obtained
before that date, an entity can apply either IFRS 3 (2004) or IFRS 3 (2008).

38. WHAT IS THE PROCEDURE WHEN THE GROUP NO LONGER


CONTROLS AN ENTITY UNDER IFRS 10?
When retrospective application is impracticable (as defined in IAS 8, that is:
when the entity cannot apply it after making every reasonable effort to do so),
the following specific rules apply.
When an investor is deconsolidating an entity, IFRS 10 shall be applied at
the date on which control is deemed to have been lost, which is the beginning
of the earliest period for which application of IFRS 10 is practicable (which
may be the period of initial application of the revised standard).
39. WHICH SECTORS ARE LIKELY TO BE THE MOST AFFECTED?
In practice, the sectors which are the most likely to be affected by the new
standard are as follows:
the funds and fund management sector, irrespective of whether the
funds in question are invested in financial instruments or real estate
assets. Fund managers often have to invest in the fund themselves
at the outset (referred to as seed money), even if the ultimate goal
is to open the fund to external investors.
Cf. question 12 on the illustrative examples included in the standard;
the infrastructure concessions sector (when the infrastructure is
located in a special purpose entity).
In both cases, this is due to the lack of any reference to a specific threshold
for exposure to risks and rewards (whereas SIC 12 referred to a majority of
risks and rewards).

35

Key points of IFRS 10 Consolidated Financial Statements in 40 questions and answers


36

40. WHAT ARE THE KEY POINTS TO REMEMBER ABOUT IFRS 10?
The key points to remember about IFRS 10 are as follows:
1. A single definition of control, which applies to both traditional
entities (subsidiaries of industrial and commercial groups) and
structured entities (special purpose entities and similar entities).
2. Control implies (a) power over the relevant activities, (b) exposure
(positive or negative) to variable returns, and (c) the ability to use
this power to affect the amount of these returns.
3. The concept of benefits is replaced by the much broader concept
of returns, which includes returns that are specific to that
investor (such as synergies, economies of scale or access to scarce
products).
4. Several additional clarifications on (a) substantive and protective
rights, (b) the distinction between an agent and a principal, (c) de
facto control, and (d) silos.
5. The accounting treatment for call options and other potential
voting rights is potentially very different (and is largely left open to
professional judgement).
6. The level of control must be reassessed regularly, especially if facts
and circumstances indicate that there may be changes to any of the
three criteria mentioned in point 2 above.
7. There is no official threshold above which consolidation is
required (when assessing the criterion which relates to exposure
to variable returns). However, the examples suggest an implied
threshold of around 20% (above which the exposure to variable
returns criterion is deemed to be met).

Key points of IFRS 10 Consolidated Financial Statements


in 40 questions and answers

8. A large amount is left open to professional judgement and there is


no decision tree in the standard.
9. No change to consolidation techniques (i.e. the question of how to
carry out consolidation).
10. Date of initial application: financial periods beginning on or
after 1January 2013 (usually retrospective, but with scope for
exceptions).

37

38

Notes

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Conception: Mazars, Communication- CAH30 FR - 07/12

Contacts:
Michel Barbet-Massin
Edouard Fossat
Didier Rimbaud